Stand out for the right reasons Financial Services Risk and Regulation. Hot topic. Insurance Distribution Directive Are you ready?

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1 August 2017 Stand out for the right reasons Financial Services Risk and Regulation Hot topic Insurance Distribution Directive Are you ready? Highlights IDD impacts both insurers and insurance intermediaries extending the scope beyond that of the IMD. In a number of areas the IDD will require that firms carefully assess their business model and current practices against the new set of rules. Firms affected by Brexit should consider carefully what IDD means for them. They should map their transaction flows through the distribution chain to understand cross border issues around IDD application and the interfaces with Solvency II for insurers. The Insurance Distribution Directive (IDD) will replace the Insurance Mediation Directive (IMD) in February Over the last ten years the FCA has gone over and above the IMD requirements to create the most mature conduct regulatory framework in Europe. To date, however, across the rest of the EU, IMD application has been softer and inconsistent. The IDD raises the bar significantly from IMD, and it is expected this time round European implementation will be stricter. On 24 July 2017 the FCA released its second consultation on the Insurance Distribution Directive (IDD). It follows on the first consultation issued earlier in March (CP17/23 and CP17/7: Insurance Distribution Directive Implementation Part 1 and 2). Firms (insurers and intermediaries) have until 23 February 2018 to implement the new regime. The IDD is a new EU wide directive aimed at ensuring minimum harmonisation of insurance regulation across the EU, creating a level playing field for insurance intermediaries and insurance distribution, regardless of the channel customers use to purchase their products. The aim is to ensure consistent prudential standards for intermediaries as well as significantly raising conduct standards, improving consumer protection and effective competition. The IDD applies to insurers, insurance intermediaries, price comparison websites/aggregators and ancillary insurance intermediaries. The conduct requirements applying to distributors (which includes insurers) vary according to the nature of the business and customer (including commercial clients). Key areas covered by the regulation include Professional, organisational and prudential requirements: covers professional indemnity cover, and training and competence requirements Conduct of business general principles including acting in customers best interest Product oversight and governance requirements (POG) Remuneration disclosure requirements Conflicts of interest disclosure Pre-contract disclosures Customer demands and needs requirements Complaints handling and out of court redress

2 Overarching IDD principle: Customers best interest The IDD requires distributors: Must always act honestly, fairly and professionally in accordance with the best interests of their customers. This new principle coupled with the continuous focus of the regulator on value in distribution chains and rules on remuneration disclosure should be an area of focus for firms 1. This is not just about always acting on the customers best interest but also being able to demonstrate it. The impact of the application of such a broad principle in practice will only become clear once the FCA shows its regulatory appetite to challenge firms in this regard. What does IDD mean for UK firms today? For more than a decade now the UK has gold plated conduct regulation under IMD. As a result, implementation of the new IDD in the UK is likely to be relatively less problematic than for EU firms and those operating pan EU. However, there are a number of areas where the IDD goes beyond current FCA rules. Consequently, UK firms will need to assess how FCA implementation of IDD affects their current business models and practices. Those UK firms operating elsewhere in the EU will need to additionally consider how each EU Member State plans to implement IDD. A key aspect of IDD is that its scope and application depends on the nature of the regulated activities performed (for example: arranging, dealing as agent, insurance, reinsurance), type of client/customer, the products sold and how they are distributed. Various exemptions exist for the application of both the regime or some of its requirements. For example, activities related to the distribution of large risks are exempted from the most onerous conduct requirements in the IDD. So a first step for insurers and intermediaries in assessing conduct impacts is to identify the contracts falling within the large risks exemption, and determine whether they can be separated operationally for the purpose of IDD implementation. The UK industry will already be familiar with some of the disclosure requirements but disclosing both the nature and basis of remuneration received might be challenging for firms in complex distribution chains or aggregators. The FCA is also putting more emphasis on firms identifying the individual customer demands and needs and has indicated that vague, non-specific statements will no longer be sufficient to comply with the new requirements. Distributors may need to revise the design of the customer journey to ensure the necessary information is gathered to offer those products that are consistent with the client-specific demands and needs. IDD includes a number of provisions in relation to product oversight and governance (POG). The FCA considers that its current handbook guidance (RPPD) broadly covers IDD requirements. It plans to move its RPPD guidance into a new sourcebook on product governance (PROD). The Markets in Financial Instruments Directive II (MiFID II) requirements go further than IDD on product governance. As a result, the FCA is considering applying MiFID II POG provisions to insurance business in the form of guidance. This will be dealt with in a third consultation to be released in September There are also specific impacts for intermediaries including the proposed extension of the client money regime to reinsurance intermediaries. A more detailed analysis of the IDD is found in Appendix 1 to this document, outlining the areas of change and the challenges involved. What does IDD mean for general insurance firms doing business in Europe? IDD is likely to demand greater implementation efforts across the EU than in the UK. For insurers and intermediaries looking to restructure due to Brexit, the implementation of IDD in the relevant jurisdictions will be a significant factor in how to manage a smooth transition successfully. There are also perimeter issues to consider under IDD, and for insurers the interface of these with Solvency II regulated activities is critical. Intermediaries involved in cross border business flows to/from the UK will need to consider where their customers/clients are, and map transaction flows through to carriers. Firms will need to understand the IDD regulated activity implications of current transaction flows and any restrictions post Brexit to then put in place compliant process flows. 1 Throughout this paper firms means insurers and insurance intermediaries. 2 Hot Topic Financial Services Risk and Regulation

3 With IDD being minimum harmonisation, each EU Member State is able to top up the regulation, and as a result it will have its own version of IDD. Currently, there are variations in the maturity of Members States conduct regimes under the IMD, for example the Dutch and Belgian regimes are currently more onerous in a number of respects. The core conduct requirements in IDD are under the remit of the host supervisor it means that a French intermediary selling products to customers/clients in Spain (through a Spanish branch/presence) will have to comply with the Spanish version of IDD for the products it sells in Spain, and the French version for the products it sells in France. Firms will need to have these flows appropriately mapped and identified early in the Brexit plans. What are the challenges for the life industry? IDD includes specific requirements for firms selling investment-based insurance products (IBIPs). In most cases the IDD requirements do not completely align to the MiFID II requirements for investment products, MiFID II being the stricter regime. However, the FCA has decided to broadly align the regime for IBIPs with MiFID II standards where appropriate. This means that in some areas such as inducements, appropriateness assessments and conflicts of interests the FCA plans to apply the new MiFID II rules and go beyond IDD requirements. What next? FCA CP23/17 is open for comments until 20 October A third consultation is expected in September 2017 and results from feedback and new rules will be published in December 2017 in time for February 2018 application. Meanwhile the European Commission is reviewing delegated acts to IDD and is expected to approve them before year end and in time for IDD implementation. Delegated acts do not need to be transposed into Member State law to come into force. These acts cover areas such as inducements, conflicts of interest, POG and suitability and appropriateness assessments. What do I need to do now? Understand how you score UK business Firms first need to understand their current level of compliance with IDD requirements. The areas highlighted in Appendix 1 give a good indication that this is not a trivial, tick box exercise and will involve several areas of the business. It will be crucial to involve the business areas from the outset when carrying out the impact analysis of some of the requirements, such as customers demands and needs, POG and disclosure. These have a wide ranging impact and affect the core of the business. Involving the right people at the right time will ensure a successful transition and implementation. Firms will also need to keep a watching brief on more rules and guidelines from EIOPA and the FCA as the regime takes shape. EU business assessment and map Brexit impact Firms that are operating in the EU and affected by Brexit will need to consider the impact of IDD on their access to the EU market and the conduct rules they will have to comply with come February The more onerous IDD requirements are expected to fall under the responsibility of the host supervisor. This opens up the possibility of firms having to comply with a number of different versions of IDD requirements in different Member States where the products are distributed. It also raises questions with regards to product oversight and governance requirements and the need for insurers to pass on information to their intermediaries to comply with the IDD requirements in the territories where they distribute. Firms will want to consider the impact of IDD and Brexit on their overall operations and transaction flows. Such analysis is not a confined compliance exercise, IDD impacts firms business, operational and finance models, so having the right people in the room is crucial for a successful implementation. See Appendix 2 for suggested approach for IDD. Contacts Jane Portas, Partner T: +44 (0) E: jane.portas@pwc.com Kareline Daguer, Director T: +44 (0) E: kareline.daguer@pwc.com Ann-Marie Stone, Senior Manager T: +44 (0) E: ann-marie.stone@pwc.com Julie Wanstall, Senior Manager T: +44 (0) E: julie.wanstall@pwc.com 3 Hot Topic Financial Services Risk and Regulation

4 Appendix 1 Highlights of key IDD impacts Area Description Who is in scope? Challenges Remuneration disclosures New requirements for pre-contract disclosure of information about distributor s remuneration. Requirement to disclose nature and basis of the remuneration received related to the insurance contract. All insurers and intermediaries except when insuring large risks 2 In scope AII s and CTI S 3 N/A for out of scope AII s Although the FCA states the industry should already be compliant the level of disclosure expected is more granular than current practice across many areas of the market. Intermediaries within a chain might find it difficult to obtain the relevant information. For aggregators it is also unclear how the disclosures should apply. Demands and needs Firms need to offer customers products that are consistent with their insurance demands and needs. Although similar to prior requirements, IDD requires a more strict approach to the process of identifying the customer specific demands and needs and then only offering products that are consistent with those. All insurers and intermediaries except when insuring large risks All AII s 4 and CTI s Non-advised basis products (for advised sales a personal recommendation is required with explanation of how the product offered meets the demands and needs of the customer). Whereas currently firms provide customers with a statement of demands and needs this tends to be fairly generic and broad brush. The challenge is to identify the individual customer demands and needs and map it to the products on offer. Implementing this change has implications to the customer journey and might lead to revision of the products on offer. It also requires clarity on distribution agreements to ensure the products are offered to the right customers regardless of who is distributing. Overall, it might lead to product and value chain simplifications. This area is closely linked with the operation of the customer best interest principle and might well be an area of regulatory focus after implementation. 2 Large risks as defined in the Solvency II Directive include: marine, aviation, transport classes and contracts with commercial policyholder of certain size (more than 250 employees, with turnover of more than 12.8m or balance sheet over 6.2m). 3 CTI = Connected Travel Insurance Intermediary. 4 AII Ancillary Insurance Intermediaries ancillary insurance intermediary means any natural or legal person, other than a credit institution or an investment firm, who, for remuneration, takes up or pursues the activity of insurance distribution on an ancillary basis, provided that all the following conditions are met: a. The principal professional activity of that natural or legal person is other than insurance distribution; b. The natural or legal person only distributes certain insurance products that are complementary to a good or service; c. The insurance products concerned do not cover life assurance or liability risks, unless that cover complements the good or service which the intermediary provides as its principal professional activity. 4 Hot Topic Financial Services Risk and Regulation

5 Area Description Who is in scope? Challenges Product Oversight and Governance arrangements for manufacturers (POG) POG applies to insurers and intermediaries that manufacture insurance products. The requirements include: identifying a target market and market segments for which a product is not considered appropriate, carrying out product analysis and reviews to check product performance and potential consumer detriment, identifying relevant distribution channels, monitoring distribution channels and providing appropriate information on the product to distributors. Manufacturers of insurance products: all insurers and in some cases intermediaries that fall under the manufacturer definition except when insuring large risks. N/A for AII s or CTI s How will the new regulations impact current design governance? What products are in scope? Identification of large risks. Manufacturer definition: when is an intermediary in scope of POG? Governance over distribution chains how will firms ensure all distributors are offering the right products to the right clients? How will MiFID II alignment affect POG requirements? Product Distribution arrangements for distributors Insurance distributors that do not manufacture products are subject to product distribution arrangements that include establishing measures and procedures for the products they intend to distribute, obtaining all relevant information from the manufacturer and defining a distribution strategy. All distributors of insurance products that are not manufacturers except contracts insuring large risks. N/A for AII s or CTI s Intermediaries must obtain appropriate knowledge about the approval process of the manufacturer, its target market and other information to be able to distribute the product. EIOPA plans to enhance exchange of information, this might lead to distributors communicating relevant information to manufacturers about sales made outside target market, summary of information on complaints per product, etc. Distributors are also expected to keep appropriate records of all relevant action taken in relation to POG arrangements. Training and competence Staff knowledge and ability: Introduces a minimum of 15 hours CPD for staff. Where staff are not already subject to this in the TC sourcebook (35 hours of CPD currently), the FCA will apply the 15 hours minimum. Minimum requirements apply to employees with responsibility for insurance distribution. This might include for example call centre operatives whose role may be limited to conducting non-advised, script-based sales but the CPD can be tailored to allow for the nature and complexity for the employee s role. Minimum knowledge criteria covers areas such as product coverage, the claims process and insurance regulation. The FCA Insurers and intermediaries Minimum knowledge criteria is also applicable to insurance and reinsurance intermediaries but the FCA intend to apply to insurance and re-insurance undertakings as well. Only applicable to employees directly involved in insurance distribution and not to ancillary roles such as HR and IT. Applies to In-Scope AII s and CTI s but not out of scope AII s The FCA expect that most of these requirements are already being met under the TC sourcebook. Where current requirements are more robust than the IDD, the FCA will maintain these. Guidance will be issued from the FCA with regards to the format and content of the CPD being modulated according to the nature and complexity of the employee s role. HR and compliance functions to undertake a cross referencing exercise to ensure that employee knowledge, ability and competency requirements align with both FCA requirements and IDD requirements. 5 Hot Topic Financial Services Risk and Regulation

6 Area Description Who is in scope? Challenges expects insurers to train their employees in these areas. There is a requirement to establish, maintain and keep appropriate records to demonstrate compliance with employee knowledge and ability requirements. Employees of insurance distributors do not need to obtain a qualification, but firms should consider employee s compliance with their IDD training and development when assessing their competence and when certifying employees under the FCA significant harm function. Insurance Product Information Document (IPID) and other product information disclosure requirements. The IDD introduces a requirement for nonlife insurance distributors to provide the customer with a standardised Insurance Product Information Document (IPID), prior to the conclusion of a contract. The IPID should provide standardised information about non-life insurance products, before the conclusion of the contract. New FCA guidance for firms to consider product governance arrangements when producing product information firms should provide the information when it will be most useful to customers, should consider the need to provide a short summary of the policy even for commercial customers, and should cooperate with all partners in distribution chain to ensure the customer information needs are met. Manufacturers of non-life insurance products except large risks. These IDD requirements will also apply to in-scope AIIs and CTI providers. IPID provision not required for commercial customers (but other general information disclosure requirements apply). FCA decided not to extend the requirement to provide an IPID beyond consumers. 5 Incorporating all the necessary information in the IPID format will require some effort from firms. The IPID format is highly prescriptive. How to judge when the information will be most useful to the customer? Summary policy information to be provided to commercial customers FCA expectation to consider. How should information be prioritised in the IPID FCA suggests that even for the same policy depending on the needs of the customer different information should be prioritise How to implement from operational perspective? 5 FCA defines consumers as any natural person who is acting for purposes which are outside his trade or profession and commercial customer as those who are not consumers (ICOBS 2.1) Client categorisation. 6 Hot Topic Financial Services Risk and Regulation

7 Area Description Who is in scope? Challenges Insurance based investment products IBIP IDD includes specific requirements for distribution of IBIPs. Current FCA rules in this area are already IDD compliant. However, FCA is considering extending MiFID II requirements to the distribution of IBIPs in the following areas: Information requirements such as all costs and charges, risk warnings and info on periodic suitability assessments, record keeping of client agreements, reports on the firm s service provided in durable medium. Suitability requirements including need for periodic suitability assessments (annual expected). Inducements: Under MiFID II inducements must be designed to enhance the quality of the service under IDD they must not have a detrimental impact. FCA will apply the MiFID test to IBIPs. Distributors and manufacturers of IBIPs. Professional clients do not need to be provided with a suitability statement on IBIPs. How to ensure inducements are designed to enhance the quality of the service to the customer? (goes beyond IDD and aligns to stricter MiFID II). Ensure systems are in place to provide all required information and carry out periodic assessments of suitability. 7 Hot Topic Financial Services Risk and Regulation

8 Appendix 2 How PwC can help you with IDD PwC is able to offer a multi-disciplinary team that draws on subject matter experts in Regulation, Tax, Transfer Pricing, People Matters, Strategy and Operations with experience of advising insurance clients on complex business, structural and operational matters. Our team has also helped businesses successfully plan and implement their regulatory and market structuring and compliance programmes. We can assist with the following services: Business, operating, finance model and legal structure analysis Design and Transition planning Target operating model design and implementation People Execution support Advising you on the impact to your business model arising from the implementation of IDD in the UK and EU, considering strategic business implications, and assessing distribution structure and transaction flow implications, analysing alternative arrangements/ options to meet your business requirements from a commercial, tax and regulatory perspective to ensure business disruption is minimised. Considering Brexit overlay for firms operating/risks in EU. Helping you to identify the implications of transitioning into a desired new business distribution model and structure, and to meet the IDD regime requirements. Analysis of the impact of various legal/regulatory considerations on your business in doing so. Support with the design and ongoing operation of your operating model adjustments to support your desired IDD end state: including governance, risk and compliance frameworks, outsource services matrices and oversight arrangements, regulated (e.g. claims handling, brokerage, data retention) and nonregulated functions Assisting with the tax implications of any cross border shared and 3P services/arrangements. Support with the design and implementation of HR/reward/Training policies to support the new operating model and IDD environment. Supporting you with all aspects of implementing changes to your business model and structure, including areas such as distribution, legal, operational and tax aspects including regulatory support with the future business-state. 8 Hot Topic Financial Services Risk and Regulation 2017 PricewaterhouseCoopers LLP. All rights reserved. In this document, PwC refers to the UK member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see for further details.

9 Stand out for the right reasons Financial services risk and regulation is an opportunity At PwC we work with you to embrace change in a way that delivers value to your customers, and long-term growth and profits for your business. With our help, you won t just avoid potential problems, you ll also get ahead. We support you in four key areas. By alerting you to financial and regulatory risks we help you to understand the position you re in and how to comply with regulations. You can then turn risk and regulation to your advantage. We help you to prepare for issues such as technical difficulties, operational failure or cyber attacks. By working with you to develop the systems and processes that protect your business you can become more resilient, reliable and effective. Adapting your business to achieve cultural change is right for your customers and your people. By equipping you with the insights and tools you need, we will help transform your business and turn uncertainty into opportunity. Even the best processes or products sometimes fail. We help repair any damage swiftly to build even greater levels of trust and confidence. Working with PwC brings a clearer understanding of where you are and where you want to be. Together, we can develop transparent and compelling business strategies for customers, regulators, employees and stakeholders. By adding our skills, experience and expertise to yours, your business can stand out for the right reasons. For more information on how we can help you to stand out visit 9 Hot Topic Financial Services Risk and Regulation